CFM51090 - Derivative contracts: the matters and computational rules: expenses

CTA09/S594A

Expenses relating to derivative contracts

CTA09/S594A sets out the matters that are taken into account in respect of derivative contracts under the rules of CTA09/PT7. These matters include expenses in respect of a company’s derivative contracts and related transactions. A related transaction is widely defined to include any disposal or acquisition (in whole or part) of rights and liabilities under the derivative contract.

S594A(2) requires such expenses be incurred directly on one of four activities specified in the legislation.

These are expenses incurred directly in:

  • Bringing derivative contracts into existence;
  • Entering into or giving effect to related transactions;
  • Making payments under a contract or in respect of a related transaction;
  • Taking steps to secure payments receivable under a contract or in respect of a related transaction.

Illustrative, but not exhaustive ,examples of such expenses are set out below.

  • Fee or commission charged by a bank for an interest rate swap.
  • Paying a premium for an option.
  • Costs of checking the credit status of the counterparty.
  • Costs directly incurred in delivering a financial or non-financial asset where a contract is settled by physical delivery.
  • Legal fees relating to the novation of a derivative contract.
  • Bank charges for making cash settlement payments or swap payments.
  • Solicitor’s fees incurred in enforcing rights under a derivative contract.

In a large number of cases, someone entering into a derivative contract will need to provide security to the other party. For example, someone buying or selling exchange-traded futures or options will need to put up margin. A company entering into an over-the-counter contract may need to provide collateral, or a guarantee, or both. Incidental costs which are directly incurred in providing such security, for example, a guarantee fee, or legal costs for entering into an ISDA Credit Support Deed, are allowable under CTA09/S595(4)(a). The margin itself will normally give rise to a separate financial instrument, for instance a relevant non-lending relationship within CTA09/PT6/CH2, CFM41020.

Expenditure is not allowable under the derivatives contract rules if it is not directly related to a specific derivative transaction. Examples are:

  • costs of general advice on risk management;
  • costs of becoming a member of a futures or options trading exchange.

Abortive expenditure

CTA09/S607 extends the scope of allowable expenses by providing that, if a company

  • incurs expenditure in connection with entering into a derivative contract, or giving effect to obligations that might arise under it, and
  • if the company actually entered into the derivative contract or related transaction, the expenditure would be allowable under CTA09/S595(3)(b),

those expenses are allowable, whether or not the company ultimately enters into the contract or related transaction. This means that expenditure may be allowable even if it proves abortive.